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Topic: Finance, Banking & Monetary Policy

For some years, hot money flowed in, adding massively to China’s foreign reserve stockpile. Speculators borrowed cheaply in U.S. dollars and bought yuan-denominated assets in anticipation of an ever-appreciating yuan. Well, this carry trade has shifted into reverse, with $91 billion in net outflows in the last quarter of 2014. And with that, the ever-appreciating yuan story has come to a close, too. Indeed, the yuan has lost 1.8% against the greenback since the New Year.

A clear picture of the drag that the hot money outflows are putting on China is shown by inspecting the annual growth rate in the People’s Republic of China’s net foreign assets. With the reserve of the carry trade, the slowdown in net foreign assets growth has been pronounced.

This, in turn, has reduced the foreign asset component of the growth in China’s money supply, putting a squeeze on the economy’s fuel supply. Indeed, China’s money growth rate has fallen well below its trend rate since mid-2012.

In an attempt to reverse the slump in China’s money supply growth, the People’s Bank has just reduced its benchmark interest rates for the second time in three months. A wise move.

Yesterday, the New York Department of Financial Services (NYDFS) issued the second draft of its “BitLicense” proposal, a special, technology-specific regulation for digital currencies like Bitcoin. For a second time, the NYDFS claims to have a strong rationale for such regulation, but it has not revealed its rationale to the public, even though it is required to do so by New York’s Freedom of Information Law.

About a year later, Superintendent Lawsky released the first draft of the “BitLicense” proposal, to strongly negative reviews from the Bitcoin community. It didn’t help that after a year’s work the NYDFS offered the statutory minimum of 45 days to comment. Relenting to public demand, the NYDFS extended the comment period.

In announcing the regulation, the NYDFS cited “extensive research and analysis” that it said justifies placing unique regulatory burdens on Bitcoin businesses. On behalf of the Bitcoin Foundation, yours truly asked to see that “extensive research and analysis” under New York’s Freedom of Information Law. The agency quickly promised timely access, but in early September last year it reversed itself and said that it may not release its research until December.

Debate over whether to subject the Federal Reserve to a policy audit has occasionally focused on the size and composition of the Fed’s balance sheet. While I don’t see this issue as central to the merits of an audit, it has given rise to a considerable amount of smug posturing. Let’s step beyond the posturing and give these questions some of the attention they deserve.

First the facts. The Fed’s balance sheet has ballooned over the last few years to about $4.5 trillion. And yes, the Fed discloses such. No argument there. The Fed, like most central banks, has traditionally conducted its open-market operations in the “short end” of the market. The various rounds of quantitative easing have changed that. For instance the vast majority of its holdings of Fannie & Freddie mortgage-backed securities ($1.7 trillion) have an average maturity of well over 10 years. Similarly the Fed’s stock of treasuries have long maturities, about a fourth of those holdings in excess of 10 years.

Now the leverage question. We all get that the Fed cannot go “bankrupt” like Lehman. But that’s because “bankrupt” is a legal condition and one from which the Fed has been exempted. Just like Fannie and Freddie cannot go “bankrupt” (they are considered legally outside the bankruptcy code). The eminent economist historian Barry Eichengreen tells us the Fed’s leverage doesn’t matter as “the central bank can simply ask the government to replenish its capital, much like when a government covers the losses of its national post office.” Some of us would say that’s a problem not a solution, just like it is with the Post Office.

Others would suggest the Fed’s leverage doesn’t matter because “the Fed creates money”. Again that misses the point. Any losses could be covered by printing money, but isn’t that inflationary? And that, of course, is just another form of taxation. So it seems Senator Paul’s primary point, that the Fed’s balance sheet exposes the taxpayer to some risk has actually been supported, not discredited, by these supposed rebuttals.

Let’s get to another issue, the maturity of the Fed’s assets. There’s a good reason central banks generally stay in the short end of the market. It avoids taking on any interest rate risk. When rates go up, bond values fall. Yes the Fed can avoid recognizing those losses by simply not selling those assets. But that creates problems of its own. If we do see inflation, normally the Fed would sell assets to drain liquidity from the market. But would the Fed be willing to sell assets at a loss? At the very least there would be some reluctance. And yes they could cover those losses by printing money, but that’s hardly helpful if the Fed finds itself in a situation of rising prices.

The point here is that the Fed’s balance sheet does raise tough questions about its exit strategy. Perhaps the economy will remain soft for years and the Fed can exit gracefully. Perhaps not. I raised this possibility before Congress a year ago. I don’t know anyone with a crystal ball on these issues. But one thing is certain, this is a debate we should be having. Its the “nothing to see here, move along” crowd that poses the true risk to our economy.

Led by Alexis Tsipras, head of Greece’s newly-elected, left-wing coalition, some other leading political lights in Europe—Messrs. Hollande and Valls in France and Renzi in Italy—are raising a big stink about fiscal austerity. Yet they always fail to define austerity. Never mind. They don’t like it. The pols have plenty of company, too. Yes, they can trot out a host of economists—from Nobelist Paul Krugman on down—to carry their water.

But public expenditures in Greece, Italy and France are not only high, but growing as a proportion of the economy. One can only wonder where the austerity is. As the first chart shows, only five of 28 European Union countries now spend a smaller proportion of national income on government than they did before the current crisis. For example, Greece spent 47.5% of national output on government in 2007 and 58.5% in 2013, an increase of 11 percentage points.

Government expenditures cut to the bone? You must be kidding. Even in the United States, where most agree that there is plenty of government largesse, the government (federal, plus state and local) still accounts for “only” 38.1% of GDP.

In the State of the Union address on January 20, President Obama said, “those at the top have never done better… Inequality has deepened.” The following day, Fox News anchor Brett Baier said, “According to the work of Emmanuel Saez, a professor at the University of California, Berkeley, during the post-recession years of 2009-2012, top earners snagged a greater share of total income growth than during the boom years of 2002-2007. In other words, income inequality has become more pronounced since the Bush administration, not less.”

Senator Bernie Sanders agrees that “in recent years, over 99 percent of all new income generated in the economy has gone to the top 1 percent.” And Senator Ted Cruz likewise confirmed that, “The top 1 percent under President Obama, the millionaires and billionaires that he constantly demagogued earned a higher share for our income than any year since 1928.”

When any statistic is so politically useful and wildly popular among left-wing Democrats and right-wing Republicans you can be pretty sure it’s baloney. Bipartisan baloney.

In November 2013, I wrote that, “Because reported capital gains and bonuses were…shifted forward from 2013 to 2012 [to avoid higher tax rates], we can expect a sizable drop in the top 1 percent’s reported income when the 2013 estimates come out a year from now. The befuddled media will doubtless figure out some way to depict that drop as an increase.” As predicted, the New York Times took one look at a 14.9% drop in top 1% incomes and concluded that “The Gains from the Recovery are Still Limited to the Top One Percent” That involved slicing the same old baloney very badly.

Yesterday morning I had a query from someone asking me to share my thoughts about the Federal Reserve Transparency Act, better known as the bill to “Audit the Fed.” Having given him a brief answer, I thought I might say a little more here.

Although Rand Paul promises that his measure will shed much-needed light on the Fed’s undertakings (the Senate version of his measure was even called “The Federal Reserve Sunshine Act”), the truth is that it’s unlikely to reveal anything of importance beyond what existing Fed audits–including those provided by Title XI of the Dodd-Frank Act (which provides for a GAO audit of the Fed’s crisis-related emergency lending)–can themselves reveal.

True, unlike existing measures Paul’s bill would also let the GAO “audit” the Fed’s conduct of monetary policy, including its open-market operations and financial dealings with other central banks. But if “sunshine” is the first word that pops into your head when contemplating this possibility, you probably have had a little too much of it already. Certainly you have not read many GAO reports.

Don’t get me wrong: the GAO does its job well, and a report by it on the Fed’s conduct of monetary policy would probably be a much better read than most academic papers on the same topic. But if you’re looking forward to seeing the GAO give the FOMC a good thrashing, or to any other sort of scintillating reading, you’re barking up the wrong tree, because what you’re likely to be in for instead is a bunch of charts and tables, accompanied by a competent but very measured and detached review of the Fed’s activities, of the sort that might prove very handy, but that is hardly likely to be the least-bit earth-shattering.

When Thomas Piketty and Emmanuel Saez release their annual estimates of top 1 percent incomes, you can count on The New York Times to put it in a front page headline with additional hype on the editorial page. This time, however, the news was that the top 1 percent had suffered a 14.9 percent decline in real income in 2013 if capital gains are included, as they always had been until now.

The New York Times heroic spin was “The Gains From the Economic Recovery Are Still Limited to the Top One Percent.” The author, Justin Wolfers of the Peterson Institute wrote, “Emmanuel Saez … has just released preliminary estimates for 2013. The share of total income (excluding capital gains) going to the top 1 percent remains above one ­sixth, at 17.5 percent. By this measure, the concentration of income among the richest Americans remains at levels last seen nearly a century ago.”

I will have more to say about this in another blog post. For now, I just want to call attention to the artistic way in which the subject was changed. Since 2008, Saez has been comparing changes in top incomes (for which he has preliminary IRS data) to incomes of the bottom 90 percent (for which IRS data are singularly inappropriate). He always included realized capital gains because that makes the top 1 percent share both larger and more cyclical.